“Groups are only smart when there is a balance between the information that everyone in the group shares and the information that each of the members of the group holds privately. It’s the combination of all of those pieces of independent information, some of them right, some of them wrong, that keeps the group wise.”
– James Surowiecki, The Wisdom of Crowds
In the last installment, I talked about the standard tender offer where a company simply buys back shares at a fixed price. Today, we will discuss the much more common form of pricing for today’s tender offers: The Modified Dutch Auction Tender Offer (“Dutch Tender”).
The term Dutch auction can trace its roots back to the 17th century. Dutch flower merchants invented this methodology as a structured way to sell flowers. A seller would conduct an auction by initially setting a price at which to sell the flowers, and this price would be lowered bit by bit until the seller found buyers for their entire stock. The modified version of the Dutch auction stipulates a price range, whereas in the original version, there are on restrictions on the clearing price.
The Dutch Tender, as it pertains to the stock market, is like an auction, except the repurchase price is gradually increased instead of decreased. It is an auction process that determines the repurchase price within a set price range (including a Low Price and a High Price) in a relatively short amount of time (usually a month or so). Shareholders have the right to tender their shares at varying price levels within the price range of the offer. To determine the purchase price, the company will start with the lowest price and multiply that by the number of shares tendered at that price. If the total value does not exceed the offer value sum, the company will repeat the process using the next step up in price and multiply that by the number of shares tendered at or below that price. This process repeats itself until either the maximum price of the price range is met, or the total purchase value exceeds the offer value sum. If the total purchase value exceeds the offer value sum, all shares will then be subject to proration.
An example will demonstrate how this process works:
Acme Industries is offering to purchase $100 million worth of stock at a range of no less than $5.00 per share and no more than $7.00 per share. At the end of the tender period, shareholders submitted the following tender requests:
At $5.00 per share, it takes 10,000,000 X $5.00 = $50 million to satisfy all of those who tendered at or below that price, but $50 million is less than the offer value sum of $100 million.
At $6.00 per share, it takes 20,000,000 X $6.00 = $120 million to satisfy all of those who tendered at or below that price. $120 million is greater than the offer value sum of $100 million. As such, shares will be prorated so that only $100 million is purchased. The proration factor will be $100 million / $120 million = ~0.83, and $6.00 is set as the repurchase price. For those who tendered at $7.00, their shares will not be repurchased. The result of the tender offer will be as follows:
As you can see, Dutch Tenders are quite a bit more complicated than your straight-up “one price” tender offers that I previously discussed in Part I. How much you’ll make in the tender offer is not only contingent on when you bought the stock and at what price you chose to tender, but also on the same actions of all the other shareholders. With that in mind, let’s look at the Dutch tender offers that have been completed so far in 2018.
A few observations from these tender offer results:
- The stock price and the transaction volume of the stock in question will often jump into the range of the tender offer on the first day of the tender offer if the stock was not trading there already (see SCKT, CTG, WHR, and ABBV)
- There is no pattern as to where the final purchase price will settle between the low end of the range and the high end of the range. For example, out of the 11 Dutch tender offers completed in 2018 thus far, the average completion percentile is 61.6%*, with 2 Dutch tenders completed at the High Price, and 1 completed at the Low Price.
- From the perspective of the individual investor who buys a stock solely for participating in the tender, one must keep a few considerations in mind. Rationally speaking, after you establish a position at a purchase price, you would want to tender at a price that is higher than your purchase price. The price you pick ultimately determines your rate of return. If you tender at a price that is closer to or even equal to the Low Price, you increase the probability that your tender will be accepted. However, you will also the increase the probability that the final Purchase Price will settle towards the low end of the price range, decreasing your total return. If you tender at a price that is closer to or even equal to the High Price, you could potentially increase your total return. However, you will also increase the probability that your tender is not accepted at all.
- Lastly, you will need to be cognizant of where the stock price is trading before the expiration of the tender offer. On the entry side, it is possible that exogenous events will cause the stock to trade below the Low Price of the range, potentially establishing attractive entry points. On the exit side, if the stock price trades to or above your tender price, it makes more sense for you to sell the stock right then and there as opposed to wait for the completion of the tender offer.
- A rough “rule of the thumb” way that I like when participating in Dutch tender offers: establish a position at or close to the Low Price, and then tender or exit at a price that is towards the middle of the range (say, the average of the Low Price and the High Price).
With that in mind, let’s look at some specific Dutch tender offers that took place this year:
- Socket Mobile (Ticker: SCKT): After announcing the tender offer with a Low Price of $3.75 and a High Price of $4.25, SCKT announced earnings for 4Q17 on 02/16/18, causing the stock to drop more than 7% on that day. SCKT stock languished at the $3.77 to $3.81 range for a few days (from 02/16/18 to 02/27/18). At that range, the downside to the Low Price was -0.5% to -1.6%, whereas the upside to the High Price was 11.5% to 12.7%, an attractive Upside-to-Downside ratio. Had one established a position during that period, one would have earned a return of 2.4% to 3.4% for a holding period of ~3 weeks.
- Computer Task Group (Ticker: CTG): The stock traded below the middle of the tender offer range ($8.05 – $9.00) or the eventual final purchase price ($8.85). In fact, if you bought the stock at any time during the tender offer period, you would have earned a return of 5.1% to 9.9%, averaging out at 7.8%.
- Herbalife (Ticker: HLF): Even though Herbalife announced the specific terms of the tender offer on 04/18/18, it announced the intent to do a tender offer earlier on 02/28/18. The stock price moved up from $46.05 on 02/28/18 to $51.51 on 04/17/18, the day before the tender. The actual offer range did not come as a surprise, so there was not the usual jump in the stock price on the first day of the tender announcement. Furthermore, the stock actually traded higher than the High Price of the offer range from 05/04/18 to 05/16/18 after positive 1Q’18 earnings.
- AbbVie (Ticker: ABBV): AbbVie announced a tender offer on 05/01/18 when the shares traded between $101 and $103. For a couple of days (05/07/18 and 05/08/18), the stock traded very close to the low end of the tender range, offering attractive entry positions. Later, the stock steadily moved up to over $106.23 by 05/21/18 and 05/22/18 (with intraday highs hitting $107.25), and this offered an attractive exit point if you stuck to a plan of exiting at the middle of the tender range. What’s wild here is that on the last day of the tender (05/29/18), the stock actually traded to the $99 range again. In fact, so many people bought shares on that day and tendered at or close to the Low Price that the company was forced to issue a correction via press release and adjusted the final purchase price from $105 to $103.
CONCLUSION
Dutch Tender offers are significantly more complicated than the simple cash tender offers mentioned in my previous post. However, with the right perspective, vigilance, and established rules for entry and exit, they still are very compelling opportunities for outsized risk-adjusted returns within a short, finite amount of time. Next time, in the final Part of this 3-part series, we will be discussing a tender offer where the consideration is not for cash, but for stock: the split-off.
*Completion percentile is calculated as (Repurchase Price – Low Price) / (High Price – Low Price). So, if the Dutch tender is priced at the Low price, the completion percentile is 0, and if the Dutch tender is priced at the High Price then the completion percentile is 100%.
This article is provided for informational purposes and does not represent a recommendation to buy or sell any security. Please see full disclosures here.
